Closing the wealth gap is a battle between China's cities

Editor’s note: In the four-part series In the Red, China Economic Review looks at how and why local governments amassed such huge debt, and the options Beijing has to deal with it. Click to read part one, part two and part three.

Residents in Bijie, Guizhou, one of the poorest cities in China’s poorest province, are always looking southeast. About 950 kilometers in that direction is the bustling metropolis of Guangzhou, one of the country’s richest cities.

In 2012, per capita GDP in Bijie was just US$2,100. In Guangzhou it was nearly US$17,000. Lifestyles in the two places are starkly different. Porsches cruise the streets of Guangzhou. In the city of Bijie, a water buffalo on the side of the road wouldn’t seem out of place.

It doesn’t take much to understand the constant stream of young Chinese flowing from places like Bijie toward prosperous cities such as Guangzhou.

Poor city governments have little to offer residents in the way of services, education, jobs and overall quality of life. Attempts to improve the situation by funding infrastructure and social projects have led many cities and provinces into debt. It’s also driven many residents from their homes as cadres sell off land to developers to fill local government coffers.

While these forces have pushed hundreds of millions of Chinese toward bigger cities, those cities have pushed back. Migrants are expensive to take in. As they have arrived in hordes over the past three decades, more-affluent cities have denied them the same access to services that local residents enjoy.

The central government is trying to work out these kinks between richer and poorer places. But any reform that targets the key aspects of China’s social safety net – namely pensions and the hukou system – will cause friction between affluent cities like Guangzhou and the backwaters of Bijie.

Saving for a rainy day

Touching China’s pension systems is a sensitive topic, Tuo Guozhu, director of the China Social Insurance Association in Beijing and a professor at Peking University, said in an interview. The funds look after the largest group of retirees in the world. Within a few years, up to 95% of China’s population could be included in some form of pension, Tuo estimates.

“The Chinese social insurance system is already fundamentally constructed but now it needs perfection,” he said.

Perfection might be a long way off. Until the mid 1990s, China’s biggest employers, state-owned enterprises (SOEs), were responsible for pensions. That changed as Beijing began culling inefficient state firms. In 1997, management of pensions was transferred from SOEs to local governments.

China now has four different pension systems, the primary of which, the Urban Enterprise Pension System (UEPS), covers people employed in cities and state enterprises. Another scheme covers government workers. The other two systems collect voluntary contributions for urban and rural workers that fall outside of the first two plans.

UEPS works well when people stay put. Most local pension funds generate revenues that can cover retirees. However, the situation becomes increasingly complex when the masses mobilize, as they have during the past 30 years. The local nature of the systems makes transferring pensions from one place to another difficult and can clog the urbanization process.

Rules between different systems vary greatly, according to an influential World Bank report on Chinese reforms published in 2012. Hopping between two cities might require workers to give up some of their pensions or perhaps even work more years to get the same payments they were entitled to.

Hukou … Who knows?

Pensions are also inextricably linked to the hukou, China’s residency permit system that divides the population into rural and urban statuses. When a worker from the countryside moves to a city, their rural status will disqualify them from entering the urban pension system.

Pensions are just the start of the difficulties surrounding the hukou system. The regime shuts out the vast majority of rural migrants – up to 160 million by some counts – from healthcare, education and social housing. At the same time, city governments do not count these workers as part of the urban population when planning infrastructure and transportation projects, leading to urban congestion.

Leaders at the top are floating some solutions. At the Third Plenum, a high-level policy meet held last month, China’s new administration said small and medium cities would open up to migrants. Details in a document released after the meeting were scant but analysts believe that many of China’s smaller cities will now be obligated to work migrants into the fold.

The document also pointed to lifting some responsibilities for pensions off the shoulders of local governments and centralizing the system set to take care of China’s rapidly aging population.

Pick a price

The plans are bold and not without controversy. Reforms like this are set to pit rich local governments against poor ones, as more prosperous cities in China are asked to foot a larger portion of the bill. Estimates exist on how much it will cost to integrate migrants into education and healthcare schemes. But they vary greatly, and some of the figures might make city leaders’ eyes bulge.

The Chinese Academy of Governance, a state-run, Beijing-based think tank, earlier this year said the process will cost the state – from the central to town level – something to the tune of US$300 billion during the next eight years, or roughly 15% of the central government’s total annual budget.

Small cities would bear the brunt of that cost, the think tank said. Small, local governments will need to fork out about 35% of the tab, or about US$8 billion through 2020.

Before the central government can launch real hukou reform, it will first need to determine the costs.

“The biggest issue at the moment is that the government doesn’t know how much extra investment is needed for one migrant to be absorbed into the hukou system,” Li Wei, a Shanghai-based analyst at Standard Chartered, said last week.

What’s in this for me?

Reforms to China’s pension system will be costly for some cities and potentially lucrative for others.

Many big cities along the manufacturing belt stretching through eastern and southern China have excess money in their pension funds after cash is paid out to retirees. Those surplus funds can then be reinvested by local governments into financial instruments such as bonds to boost their pots.

However, in provinces such as Guizhou, and in cities like Bijie, where agriculture is a primary source of revenue, pension funds generate far smaller revenues. Poor cities and provinces often must dip into the personal pension accounts of current workers in order to pay for retired people.

The disparity between wealthy and impoverished regions in China is set to collide head on with the central government’s blueprint for taking over pensions. Guangzhou officials will no doubt resist the pooling of their sizable accounts in order to pay for elderly in Bijie.

“If you pool a rich city and a poor city together, the rich guy is always going to say: ‘What do I get out of this?’ ” said Albert Park, an economics professor at Hong Kong University of Science and Technology. For Tuo at Peking University, discrepancies between rich and poor areas will
make integrating all funds nearly impossible.

Paying up

Regional governments can squabble. But this constraint on urban migration is hurting China’s growth. Fully integrated urban residents consume far more than those in rural areas. If cities do not absorb new urbanities, domestic consumption will lag, undermining one of the central government’s main drivers for economic development.

Cities also need laborers. Social benefits and pensions for new arrivals attract them; local authorities that cannot provide will therefore struggle. “It can really be a disincentive to moving if you don’t think the years that you’ve put in are really going to count toward your pension,” said Park.

Senior policymakers need to figure out how to enable smaller local governments to provide social programs without driving up their debts. Dolloping social responsibilities such as pensions, healthcare and even law and order onto the central government’s plate would help ease the spending pressure on local government budgets, Moody’s Investors Services said in a report last month.

Proposing a master plan for China’s cities of the future is one thing. Pulling them out of debt, evening off development while also making them equitable is another. The central government will need to work out the details in a hurry. The country’s growth depends on it.

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